While he does dis­cuss Fish­er’s the­o­ry, he pro­vides only a par­o­dy of it–in which he nonethe­less notes that Fish­er’s pol­i­cy advice was influ­en­tial:

“Fish­er envi­sioned a dynam­ic process in which falling asset and com­mod­i­ty prices cre­at­ed pres­sure on nom­i­nal debtors, forc­ing them into dis­tress sales of assets, which in turn led to fur­ther price declines and finan­cial dif­fi­cul­ties. His diag­no­sis led him to urge Pres­i­dent Roo­sevelt to sub­or­di­nate exchange-rate con­sid­er­a­tions to the need for refla­tion, advice that (ulti­mate­ly) FDR fol­lowed.

He then explains that neo­clas­si­cal econ­o­mists in gen­er­al read­i­ly dis­missed Fish­er’s the­o­ry, for rea­sons that are very instruc­tive:

Fish­er’s idea was less influ­en­tial in aca­d­e­m­ic cir­cles, though, because of the coun­ter­ar­gu­ment that debt-defla­tion rep­re­sent­ed no more than a redis­tri­b­u­tion from one group (debtors) to anoth­er (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­gin­al spend­ing propen­si­ties among the groups, it was sug­gest­ed, pure redis­tri­b­u­tions should have no sig­nif­i­cant macro­eco­nom­ic effects. ” (Bernanke 1995, p. 17)

Bernanke him­self does try to make sense of Fish­er with­in a neo­clas­si­cal frame­work, which I’ll get to below; but the gen­er­al neo­clas­si­cal reac­tion to Fish­er that he describes is a per­fect exam­ple of the old (and very apt!) joke that an econ­o­mist is some­one who, hav­ing heard that some­thing works in prac­tice, then ripostes “Ah! But does it work in the­o­ry?”.

It is also–I’m sor­ry, there’s just no oth­er word for it–mind-numbingly stu­pid. A debt-defla­tion trans­fers income from debtors to cred­i­tors? From, um, peo­ple who default on their mort­gages to the peo­ple who own the mort­gage-backed secu­ri­ties, or the banks?

Well then, put your hands up, all those cred­i­tors who now feel sub­stan­tial­ly bet­ter off cour­tesy of our con­tem­po­rary debt-defla­tion…

What??? No-one? But sure­ly you can see that in the­o­ry…

The only way that I can make sense of this non­sense is that neo­clas­si­cal econ­o­mists assume that an increase in debt means a trans­fer of income from debtors to cred­i­tors (equal to the ser­vic­ing cost of the debt), and that this has no effect on the econ­o­my apart from redis­trib­ut­ing income from debtors to cred­i­tors. So ris­ing debt is not a prob­lem.

Sim­i­lar­ly, a debt-defla­tion then means that cur­rent nom­i­nal incomes fall, rel­a­tive to accu­mu­lat­ed debt that remains con­stant. This increas­es the real val­ue of inter­est pay­ments on the debt, so that a debt-defla­tion also caus­es a trans­fer from debtors to creditors–though this time in real (infla­tion-adjust­ed) terms.

Do I have to spell out the prob­lem here? Only to neo­clas­si­cal econ­o­mists, I expect: dur­ing a debt-defla­tion, debtors don’t pay the inter­est on the debt–they go bank­rupt. So debtors lose their assets to the cred­i­tors, and the cred­i­tors get less–losing both their inter­est pay­ments and large slabs of their prin­ci­pal, and get­ting no or dras­ti­cal­ly deval­ued assets in return. Nobody feels bet­ter off dur­ing a debt-defla­tion (apart from those who have accu­mu­lat­ed lots of cash before­hand). Both debtors and cred­i­tors feel and are poor­er, and the prob­lem of non-pay­ment of inter­est and non-repay­ment of prin­ci­pal often makes cred­i­tors com­par­a­tive­ly worse off than debtors (just ask any of Bernie Mad­of­f’s ex-clients).

Back to Bernanke’s take on Fish­er, rather than the gener­ic neo­clas­si­cal idio­cy on debt-defla­tion. First­ly, Bernanke’s “sum­ma­ry” of Fish­er’s argu­ment starts with asset price defla­tion: “Fish­er envi­sioned a dynam­ic process in which falling asset and com­mod­i­ty prices cre­at­ed pres­sure on nom­i­nal debtors…”.

Sor­ry Ben, but (to use a bit of crude Aus­tralian ver­nac­u­lar), this is an “arse about tit” read­ing of Fish­er. Fish­er’s dynam­ic process began with exces­sive debt, not with falling asset prices. You have con­fused cause and effect in Fish­er’s the­o­ry: exces­sive debt and the delever­ag­ing process that engen­dered lead to falling asset and com­mod­i­ty prices as symp­toms (which then ampli­fy the ini­tial prob­lem of exces­sive debt in a pos­i­tive feed­back process). To make this con­crete, Fish­er referred to:

I hope that’s clear enough that, in Fish­er’s argu­ment, overindebt­ed­ness is the first fac­tor and defla­tion the second–and in fact, Fish­er argues that overindebt­ed­ness caus­es defla­tion, if the ini­tial rate of infla­tion is low enough (he also coun­te­nances the sit­u­a­tion in which infla­tion is high­er and defla­tion does­n’t even­tu­ate, which he argues won’t lead to a Depres­sion). Before I dis­cuss Bernanke’s own attempt to express what his mis­in­ter­pre­ta­tion of Fish­er in neo­clas­si­cal form, it’s worth set­ting Fish­er’s own causal sequence out in full. In his Econo­met­ri­ca paper, Fish­er argued that the process that leads to a Depres­sion is the fol­low­ing:

“(1) Debt liq­ui­da­tion leads to dis­tress sell­ing and to

(2) Con­trac­tion of deposit cur­ren­cy, as bank loans are paid off, and to a slow­ing down of veloc­i­ty of cir­cu­la­tion. This con­trac­tion of deposits and of their veloc­i­ty, pre­cip­i­tat­ed by dis­tress sell­ing, caus­es

(3) A fall in the lev­el of prices, in oth­er words, a swelling of the dol­lar. Assum­ing, as above stat­ed, that this fall of prices is not inter­fered with by refla­tion or oth­er­wise, there must be

(4) A still greater fall in the net worths of busi­ness, pre­cip­i­tat­ing bank­rupt­cies and

(5) A like fall in prof­its, which in a “cap­i­tal­is­tic,” that is, a pri­vate-prof­it soci­ety, leads the con­cerns which are run­ning at a loss to make

(6) A reduc­tion in out­put, in trade and in employ­ment of labor. These loss­es, bank­rupt­cies, and unem­ploy­ment, lead to

(7) Pes­simism and loss of con­fi­dence, which in turn lead to

(8) Hoard­ing and slow­ing down still more the veloc­i­ty of cir­cu­la­tion. The above eight changes cause

(9) Com­pli­cat­ed dis­tur­bances in the rates of inter­est, in par­tic­u­lar, a fall in the nom­i­nal, or mon­ey, rates and a rise in the real, or com­mod­i­ty, rates of inter­est.” (Econo­met­ri­ca, 1933, Vol­ume 1, p. 342)

In its own way, this is a very sim­ple process to both under­stand and to mod­el. To under­stand it, all we have to do is look at the cur­rent eco­nom­ic sit­u­a­tion in the USA–all nine stages of Fish­er’s process are already well under way there. I’ve also mod­elled the debt com­po­nent of this process in my papers on finan­cial insta­bil­i­ty (and the defla­tion aspect too in oth­er research I’ve yet to pub­lish, but which will be in my forth­com­ing book for Edward Elgar, Finance and Eco­nom­ic Break­down [expect­ed pub­li­ca­tion date is 2011]).

Because an essen­tial aspect of Fish­er’s rea­son­ing was the need to aban­don the fic­tion that a mar­ket econ­o­my is always in equi­lib­ri­um.

The notion that a mar­ket econ­o­my is in equi­lib­ri­um at all times is of course absurd: if it were true, prices, incomes–even the state of the weather–would always have to be “just right” at all times, and there would be no eco­nom­ic news at all, because the news would always be that “every­thing is still per­fect”. Even neo­clas­si­cal econ­o­mists implic­it­ly acknowl­edge this by the way they analyse the impact of tar­iffs for exam­ple, by show­ing to their stu­dents how, by increas­ing prices, tar­iffs dri­ve the sup­ply above the equi­lib­ri­um lev­el and dri­ve the demand below it.

The rea­son neo­clas­si­cal econ­o­mists cling to the con­cept of equi­lib­ri­um is that, for his­tor­i­cal rea­sons, it has become a dom­i­nant belief with­in that school that one can only mod­el the econ­o­my if it is assumed to be in equi­lib­ri­um.

From the per­spec­tive of real sciences–and of course engineering–that is sim­ply absurd. The econ­o­my is a dynam­ic sys­tem, and like all dynam­ic sys­tems in the real world, it will be nor­mal­ly out of equi­lib­ri­um. That is not a bar­ri­er to math­e­mat­i­cal­ly mod­el­ling such sys­tems however–one sim­ply has to use “dif­fer­en­tial equa­tions” to do so. There are also many very sophis­ti­cat­ed tools that have been devel­oped to make this much eas­i­er today–largely sys­tems engi­neer­ing and con­trol the­o­ry tech­nol­o­gy (such as Simulink, Vis­sim, etc.)–than it was cen­turies ago when dif­fer­en­tial equa­tions were first devel­oped.

Some neo­clas­si­cals are aware of this tech­nol­o­gy, but in my expe­ri­ence, it’s a tiny minority–and the major­i­ty of bog stan­dard neo­clas­si­cal econ­o­mists aren’t even aware of dif­fer­en­tial equa­tions (they under­stand dif­fer­en­ti­a­tion, which is a more lim­it­ed but foun­da­tion­al math­e­mat­i­cal tech­nique). They believe that if a process is in equi­lib­ri­um over time, it can be mod­elled, but if it isn’t, it can’t. And even the “high priests” of eco­nom­ics, who should know bet­ter, stick with equi­lib­ri­um mod­el­ling at almost all times.

Equi­lib­ri­um has thus moved from being a tech­nique used when econ­o­mists knew no bet­ter and had no tech­nol­o­gy to han­dle out of equi­lib­ri­um phenomena–back when Jevons, Wal­ras and Mar­shall were devel­op­ing what became neo­clas­si­cal eco­nom­ics in the 19th cen­tu­ry, and thought that com­par­a­tive sta­t­ics would be a tran­si­tion­al method­ol­o­gy pri­or to the devel­op­ment of tru­ly dynam­ic analy­sis –into an “arti­cle of faith”. It is as if it is a denial of all that is good and fair about cap­i­tal­ism to argue that at any time, a mar­ket econ­o­my could be in dis­e­qui­lib­ri­um with­out that being the fault of bungling gov­ern­ments or nasty trade unions and the like.

And so to this day, the pin­na­cle of neo­clas­si­cal eco­nom­ic rea­son­ing always involves “equi­lib­ri­um”. Lead­ing neo­clas­si­cals devel­op DSGE (“Dynam­ic Sto­chas­tic Gen­er­al Equi­lib­ri­um”) mod­els of the econ­o­my. I have no problem–far from it!–with mod­els that are “Dynam­ic”, “Sto­chas­tic”, and “Gen­er­al”. Where I draw the line is “Equi­lib­ri­um”. If their mod­els were to be tru­ly Dynam­ic, they should be “Dis­e­qui­lib­ri­um” models–or mod­els in which whether the sys­tem is in or out of equi­lib­ri­um at any point in time is no hin­drance to the mod­el­ling process.

Instead, with this fix­a­tion on equi­lib­ri­um, they attempt to analyse all eco­nom­ic process­es in a hypo­thet­i­cal free mar­ket econ­o­my as if it is always in equilibrium–and they do like­wise to the Great Depres­sion.

Before the Great Depres­sion, Fish­er made the same mis­take. His most notable con­tri­bu­tion (for want of a bet­ter word!) to eco­nom­ic the­o­ry was a mod­el of finan­cial mar­kets as if they were always in equi­lib­ri­um.

Fish­er was in some sens­es a pre­de­ces­sor of Bernanke: though he was nev­er on the Fed­er­al Reserve, he was Amer­i­ca’s most renowned aca­d­e­m­ic econ­o­mist dur­ing the ear­ly 20th cen­tu­ry. He ruined his rep­u­ta­tion for aeons to come by also being a news­pa­per pun­dit and cheer­leader for the Roar­ing Twen­ties stock mar­ket boom (and he ruined his for­tune by putting his mon­ey where his mouth was and tak­ing out huge mar­gin loan posi­tions on the back of the con­sid­er­able wealth he earned from invent­ing the Rolodex).

Chas­tened and effec­tive­ly bank­rupt­ed, he turned his mind to work­ing out what on earth had gone wrong, and after about three years he came up with the best expla­na­tion of how Depres­sions occur (pri­or to Min­sky’s bril­liant blend­ing of Marx, Keynes, Fish­er and Schum­peter in hisFinan­cial Insta­bil­i­ty Hypoth­e­sis [here’s anoth­er link to this paper]).

Pri­or to this life-alter­ing expe­ri­ence how­ev­er, as a faith­ful neo­clas­si­cal econ­o­mist, Fish­er por­trayed the mar­ket for loans as essen­tial­ly no dif­fer­ent from any oth­er mar­ket in neo­clas­si­cal thought: it con­sist­ed of inde­pen­dent sup­ply of and demand func­tions, and a price mech­a­nism that set the rate of inter­est by equat­ing these two functions–thus putting the mar­ket into a state of equi­lib­ri­um.

How­ev­er even with this abstrac­tion, he had to admit that there were two dif­fer­ences between the “mar­ket for loan­able funds” and a stan­dard com­mod­i­ty mar­ket: first­ly that the loan­able fund mar­ket involves com­mit­ments over time, where­as in stan­dard neo­clas­si­cal mythol­o­gy, com­mod­i­ty mar­kets are barter mar­kets where pay­ment and deliv­ery take place instan­ta­neous­ly; and sec­ond­ly, it is unde­ni­able that some­times peo­ple don’t live up to those com­mit­ments over time–they go bank­rupt.

Fish­er dealt with these dif­fer­ences in the time-hon­oured neo­clas­si­cal man­ner: he assumed them away. He imposed two con­di­tions on his mod­els:

“(A) The mar­ket must be cleared—and cleared with respect to every inter­val of time. (B) The debts must be paid.” ( Irv­ing Fish­er, 1930, The The­o­ry of Inter­est. New York: Kel­ley & Mill­man p. 495)

Fish­er did dis­cuss some prob­lems with these assump­tions, but in keep­ing with the neo­clas­si­cal delu­sion that one could­n’t mod­el process­es out of equi­lib­ri­um, these prob­lems did­n’t lead to a revi­sion of his mod­el.

Of course, if Fish­er had been a real­ist, he would have admit­ted to him­self that a mod­el that pre­sumes the econ­o­my is always in equi­lib­ri­um will be a mis­lead­ing guide to the behav­iour of the actu­al econ­o­my. But instead, as seems to hap­pen to all devo­tees of neo­clas­si­cal eco­nom­ics, he began to see his mod­el as the real world–and used it to explain the Stock Mar­ket bub­ble of the 1920s as not due to “irra­tional exu­ber­ance”, but due to the won­der­ful work­ings of a mar­ket econ­o­my in equi­lib­ri­um.

Since Wall Street was also assumed to be in equi­lib­ri­um, stock prices were jus­ti­fied. And he defend­ed the bub­ble as rep­re­sent­ing a real improve­ment in the liv­ing stan­dards of Amer­i­cans, because:

“We are now apply­ing sci­ence and inven­tion to indus­try as we nev­er applied it before. We are liv­ing in a new era, and it is of the utmost impor­tance for every busi­ness­man and every banker to under­stand this new era and its impli­ca­tions… All the resources of mod­ern sci­en­tif­ic chem­istry, met­al­lur­gy, elec­tric­i­ty, are being utilized–for what? To make big incomes for the peo­ple of the Unit­ed States in the future, to add to the div­i­dends of cor­po­ra­tions which are han­dling these new inven­tions, and nec­es­sar­i­ly, there­fore, to raise the prices of stocks which rep­re­sent shares in these new inven­tions.” (Fish­er, Octo­ber 23rd 1929, in a speech to a bankers’ asso­ci­a­tion)

Have you heard that one before: a “new era”? If I had a dol­lar for every time I saw that twad­dle used to jus­ti­fy com­pa­nies with neg­a­tive earn­ings hav­ing sky­high val­u­a­tions dur­ing the Inter­net Bub­ble…

Fish­er even dis­missed the 6% fall in the stock mar­ket that had occurred in the day before his speech as due to “a cer­tain lunatic fringe in the stock mar­ket, and there always will be when­ev­er there is any suc­cess­ful bear move­ment going on… they will put the stocks up above what they should be and, when fright­ened, … will imme­di­ate­ly want to sell out.”

The future, he told the assem­bled bankers, was rosy indeed:

Great pros­per­i­ty at present and greater pros­per­i­ty in view in the future … rather than spec­u­la­tion … explain the high stock mar­kets, and when it is final­ly rid of the lunatic fringe, the stock mar­ket will nev­er go back to 50 per cent of its present lev­el… We shall not see very much fur­ther, if any, reces­sion in the stock mar­ket, but rather … a resump­tion of the bull mar­ket, not as rapid­ly as it has been in the past, but still a bull rather than a bear move­ment.” (Fish­er 1929)

Pri­or to this speech, he had made his fate­ful­ly wrong pre­dic­tion on the future course of the Dow Jones in the New York Times. For the record, his state­ment was:

“Stock prices have reached what looks like a per­ma­nent­ly high plateau. I do not feel that there will soon, if ever, be a fifty or six­ty point break below present lev­els, such as Mr. Bab­son has pre­dict­ed. I expect to see the stock mar­ket a good deal high­er than it is today with­in a few months.”

Well, so much for all that. The stock mar­ket crash con­tin­ued for three years, unem­ploy­ment blew out from lit­er­al­ly zero (as record­ed by the Nation­al Bureau of Eco­nom­ic Research) to 25 per­cent, Amer­i­ca’s GDP col­lapsed, prices fell… the Great Depres­sion occurred.

At first, Fish­er was com­plete­ly flum­moxed: he had no idea why it was hap­pen­ing, and blamed “spec­u­la­tors” for the fall (though not of course for the rise!) of the mar­ket, lack of con­fi­dence for its con­tin­u­ance, and so on… But expe­ri­ence ulti­mate­ly proved a good if painful teacher, when he devel­oped “the Debt-Defla­tion The­o­ry of Great Depres­sions”.

An essen­tial aspect of this new the­o­ry was the aban­don­ment of the con­cept of equi­lib­ri­um.

In his paper, he began by say­ing that:

We may ten­ta­tive­ly assume that, ordi­nar­i­ly and with­in wide lim­its, all, or almost all, eco­nom­ic vari­ables tend, in a gen­er­al way, to ward a sta­ble equi­lib­ri­um. In our class­room expo­si­tions of sup­ply and demand curves, we very prop­er­ly assume that if the price, say, of sug­ar is above the point at which sup­ply and demand are equal, it tends to fall; and if below, to rise.

How­ev­er, in the real world:

New dis­tur­bances are, human­ly speak­ing, sure to occur, so that, in actu­al fact, any vari­able is almost always above or below the ide­al equi­lib­ri­um.

There­fore in the­o­ry as well as in real­i­ty, dis­e­qui­lib­ri­um must be the rule:

“The­o­ret­i­cal­ly there may be—in fact, at most times there must be— over- or under-pro­duc­tion, over- or under-con­sump­tion, over- or under spend­ing, over- or under-sav­ing, over- or under-invest­ment, and over or under every­thing else. It is as absurd to assume that, for any long peri­od of time, the vari­ables in the eco­nom­ic orga­ni­za­tion, or any part of them, will “stay put,” in per­fect equi­lib­ri­um, as to assume that the Atlantic Ocean can ever be with­out a wave.” (Fish­er 1933, p. 339; empha­sis added)

He then con­sid­ered a range of “usu­al sus­pects” for crises–the ones often put for­ward by so-called Marx­ists such as “over-pro­duc­tion”, “under-con­sump­tion”, and the like, and that favourite for neo­clas­si­cals even today, of blam­ing “under-con­fi­dence” for the slump. Then he deliv­ered his intel­lec­tu­al (and per­son­al) coup de grâce:

I ven­ture the opin­ion, sub­ject to cor­rec­tion on sub­mis­sion of future evi­dence, that, in the great booms and depres­sions, each of the above-named fac­tors has played a sub­or­di­nate role as com­pared with two dom­i­nant fac­tors, name­ly over-indebt­ed­ness to start with and defla­tion fol­low­ing soon after; also that where any of the oth­er fac­tors do become con­spic­u­ous, they are often mere­ly effects or symp­toms of these two. In short, the big bad actors are debt dis­tur­bances and price- lev­el dis­tur­bances.

While quite ready to change my opin­ion, I have, at present, a strong con­vic­tion that these two eco­nom­ic mal­adies, the debt dis­ease and the price-lev­el dis­ease (or dol­lar dis­ease), are, in the great booms and depres­sions, more impor­tant caus­es than all oth­ers put togeth­er…

Thus over-invest­ment and over-spec­u­la­tion are often impor­tant; but they would have far less seri­ous results were they not con­duct­ed with bor­rowed mon­ey. That is, over-indebt­ed­ness may lend impor­tance to over-invest­ment or to over-spec­u­la­tion.

The same is true as to over-con­fi­dence. I fan­cy that over-con­fi­dence sel­dom does any great harm except when, as, and if, it beguiles its vic­tims into debt. (Fish­er 1933, pp. 340–341. Emphases added.)

From this point on, he elab­o­rat­ed his the­o­ry of the Great Depres­sion which had as its essen­tial start­ing points the propo­si­tions that debt was above its equi­lib­ri­um lev­el and that the rate of infla­tion was low. Start­ing from this posi­tion of dis­e­qui­lib­ri­um, he described the 9 step chain reac­tion shown above.

Of course, if the econ­o­my had been in equi­lib­ri­um to begin with, the chain reac­tion could nev­er have start­ed. By pre­vi­ous­ly fool­ing him­self into believ­ing that the econ­o­my was always in equi­lib­ri­um, he, the most famous Amer­i­can econ­o­mist of his day, com­plete­ly failed to see the Great Depres­sion com­ing.

How about Bernanke today? Well, as Mark Twain once said, his­to­ry does­n’t repeat, but it sure does rhyme. Just four years ago, as a Gov­er­nor of the Fed­er­al Reserve, Bernanke was an enthu­si­as­tic con­trib­u­tor to the “debate” with­in neo­clas­si­cal eco­nom­ics that the glob­al econ­o­my was expe­rien­ing “The Great Mod­er­a­tion”, in which the trade cycle was a thing of the past–and he con­grat­u­lat­ed the Fed­er­al Reserve and aca­d­e­m­ic econ­o­mists in gen­er­al for this suc­cess, which he attrib­uted to bet­ter mon­e­tary pol­i­cy:

“In the remain­der of my remarks, I will pro­vide some sup­port for the “improved-mon­e­tary-pol­i­cy” expla­na­tion for the Great Mod­er­a­tion.”

Good call Ben. We have now moved from “The Great Mod­er­a­tion!” to “The Great Depres­sion?” as the debat­ing top­ic du jour.

On that front, his analy­sis of what caused the Great Depres­sion cer­tain­ly does­n’t imbue con­fi­dence. This chap­ter (first pub­lished in 1995 in the neo­clas­si­cal Jour­nal of Mon­ey Cred­it and Bank­ing [ Feb­ru­ary 1995, v. 27, iss. 1, pp. 1–28]–the same year my Min­skian mod­el of Great Depres­sions was pub­lished in the non-neo­clas­si­cal Jour­nal of Post Key­ne­sian Eco­nom­ics [Vol. 17, No. 4, pp. 607–635]) con­sid­ers sev­er­al pos­si­ble caus­es:

A neo­clas­si­cal, laboured re-work­ing of Fish­er’s debt-defla­tion hypoth­e­sis, to inter­pret it as a prob­lem of “agency”–“Intuitively, if a bor­row­er can con­tribute rel­a­tive­ly lit­tle to his or her own project and hence must rely pri­mar­i­ly on exter­nal finance, then the bor­row­er’s incen­tives to take actions that are not in the lender’s inter­est may be rel­a­tive­ly high; the result is both dead­weight loss­es (for exam­ple, inef­fi­cient­ly high risk-tak­ing or low effort) and the neces­si­ty of cost­ly infor­ma­tion pro­vi­sion and mon­i­tor­ing)” (p. 17);

Aggre­gate demand shocks from the return to the Gold Stan­dard and its effect on world mon­ey sup­plies; and

None of these “caus­es” includes exces­sive pri­vate debt–the phe­nom­e­non that I hope now even Ben Bernanke can see was the cause of the Great Depression–and the rea­son why he and neo­clas­si­cal econ­o­mists like him are no longer dis­cussing “The Great Mod­er­a­tion”.

Whle they were doing that, a minor­i­ty of economists–myself included–were avid­ly devel­op­ing both Fish­er and Min­sky’s the­o­ries of Great Depres­sions. We are known gen­er­al­ly as “Post Key­ne­sian” econ­o­mists, and there Min­sky is an intel­lec­tu­al hero. And how did Ben han­dle Min­sky? I have yet to read all of the Essays, but a blog­ger who has made the fol­low­ing com­ment:

In the entire vol­ume (Bernanke, ‘Essays on Great Depres­sion’, 2000, Prince­ton) there is a sin­gle refence to Min­sky in Part Two, page 43 — “Hyman Min­sky (1977) and Car­les Kindle­berg­er (1978) have … argued for the inher­ent insta­bil­i­ty of the finan­cial sys­tem but in doing so have had to depart from the assump­tion of ratio­nal eco­nom­ic behav­iour.” A foot­note adds — “I do not deny the pos­si­ble impor­tance of irra­tional­i­ty in eco­nom­ic life; how­ev­er it seems that the best research strat­e­gy is to push the ratio­nal­i­ty pos­tu­late as far as it will go.”

No need for any com­ment!!!!!!!

Indeed! Hav­ing not prop­er­ly com­pre­hend­ed the best con­tem­po­rary expla­na­tion of the Great Depres­sion, and dis­missed the best mod­ern expla­na­tion because it did­n’t make an assump­tion that neo­clas­si­cal econ­o­mists insist upon, Bernanke is now trapped repeat­ing his­to­ry (inci­den­tal­ly, this com­ment by Bernanke also gives the lie to the “assump­tions don’t mat­ter, it’s only the results that count” non­sense that Fried­man dished up as neo­clas­si­cal eco­nom­ic methodology–neoclassical econ­o­mists in fact care des­per­ate­ly about their assump­tions and are will­ing to dis­miss rival the­o­ries sim­ply because they don’t make the same assump­tions, regard­less of how accu­rate they are). It is painful­ly obvi­ous that the real cause of this cur­rent finan­cial cri­sis was the exces­sive build-up of debt dur­ing pre­ced­ing spec­u­la­tive manias dat­ing back to the mid-1980s. The real dan­ger now is that, on top of this debt moun­tain, we are start­ing to expe­ri­ence the slip­pery slope of falling prices.

In oth­er words, the cause of our cur­rent finan­cial cri­sis is debt com­bined with deflation–precisely the forces that Irv­ing Fish­er described as the caus­es of the Great Depres­sion back in 1933.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.

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